Thursday, 26 May 2016

Incentives matter: tobacco file

One of the great things about prices is that they provide incentives.

The graph above shows the effects of the introduction of a tax on tobacco. Prior to the law’s enactment in 2009, the tax rates on roll-your-own tobacco and pipe tobacco were the same. One effect of the new law was to make the tax rate on roll-your-own tobacco over US$20 per pound higher than the tax on pipe tobacco.

You can see what happened. Consumers, not very surprisingly, substitute from the dearer product to the cheaper product, changing the demand for both products, and in this case potentially undoing some of the public health benefits the tax was intended to encourage. How did politicians not see this coming?